Payroll schemes traditionally fall into three categories: paying wages for employees who don’t exist (also known as ghost employee schemes), paying workers who do exist for more hours or at a higher pay rate than they deserve, and overpaying commissions. Commissions are rarely used in library compensation, so this section will focus on the two remaining types of payroll schemes, which are found in libraries.
Ghosts in the Library
A Case of Nonhaunting
Chippewa Trails library system had an extensive array of branch libraries that extended over three counties. Although the system office processed each library’s payroll, the individual branches were responsible for hiring their own staff and for sending in the time cards on which weekly paychecks were based. The branch manager was responsible for hiring and for signing off on the weekly pay sheets. Although the application materials were
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reviewed and stored at the central office, no one except the branch manager ever spoke directly with new hires. Nor did any- one other than the branch manager ever check to see if the hires were on the job.
The system director made a practice of stopping by branches and chatting with employees. She happened to make an unan- nounced appearance at the Elkton branch on a day when the manager was out sick and ended up chatting with the children’s librarian. During the course of the conversation, the librarian asked when the funds would become available for a program as- sistant. “According to the branch manager,” she said, “the funds aren’t there this year. We could sure use the help.” The director left with a promise to look into the matter. She was confused be- cause the funds had been included, and, in fact, the branch man- ager had hired an assistant over a year ago.
A review of the branch’s finances showed an employee had been issued paychecks for over a year. An even closer examina- tion, however, uncovered that the assistant’s Social Security number was only one digit different from the director’s. A subse- quent investigation disclosed that the branch manager had been cashing the paychecks and had collected more than $25,000 be- fore she was discovered. She was convicted of payroll fraud, lost her job, and was placed on three years of supervised probation.
She continues to pay restitution.
How a Ghost Employee Scheme Works
The system just described is known as a ghost employee scheme. In it, a fictitious employee is created (usually by a supervisor, but sometimes in collusion with an employee in payroll or human resources) who is issued a paycheck even though no employee exists. The supervisor and his or her conspirators falsify the ghost employee’s time records and deposit the paychecks. The schemes can become quite elaborate with bogus evalua- tions and even vacations or promotions for the ghost employee.
Ghost employees can also be created from legitimate employees who are terminated or who leave and are never removed from the payroll. In some cases, the supervisor continues to submit bogus time records; how- ever, if the employee is salaried, the system may automatically continue to issue paychecks until the employee is removed from the system.
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Creating a Ghost
In order to create a ghost employee, the fraudster typically proceeds through four steps.
STEP 1: HIRING THE GHOST EMPLOYEE
The process of creating a ghost employee begins with adding the em- ployee to the payroll—that is, hiring him or her. In cases where hiring is decentralized, supervisors often have a great deal of independence in de- ciding who to add to the payroll. By itself, this isn’t a problem; libraries can gain a number of efficiencies by allowing local autonomy. In addi- tion to reducing delays in hiring, local managers usually have a better idea of their labor pool, and local autonomy can promote greater own- ership of the branch and better morale. The difficulty comes (as in our beginning case) in situations where there is no additional oversight con- cerning the hires. In our scenario, the branch manager was solely respon- sible both for hiring new employees and for verifying the hours they worked.
Even if hiring is more centralized, however, it’s possible to acquire ghost employees. The key to overcoming centralized hiring lies in the payroll accounting function. In many bureaucracies, an employee need only exist as a computer file in order to generate a paycheck. If the pay- roll clerk or a similar person has the power to add an individual, and if there is no additional review of individual pay records, then it’s still pos- sible to add a nonexistent employee. However, in that case it may be nec- essary to collude with a supervisor in order to accomplish the second step: collecting the time worked.
STEP 2: COLLECTING TIME INFORMATION
Once a ghost employee has been added, the next step is to collect evidence that the fictitious employee worked so that a paycheck can be generated.
Employees are usually paid based on the time they work in a given pay period. Often, employees keep their own time records, which are ap- proved by a supervisor before being sent to payroll. An unscrupulous su- pervisor can fabricate a time sheet for the ghost employee and send it to the payroll department along with the rest of the legitimate employees’
time sheets. Because the ghost employee already has an identity in the payroll system, the payroll department simply enters the time data and a check is subsequently created.
In cases where someone in the payroll department is working alone, a time sheet from a supervisor may not be necessary. The employee
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simply enters time data for the ghost worker directly into the payroll system. The supervisor may not, in fact, be aware that the ghost em- ployee has been added to his or her department.
If the ghost employee has been added as a salaried employee, time sheets may not be necessary. Depending on the nature of the employee’s compensation, once the salaried employee has been entered, the system simply produces a paycheck at regular intervals (weekly, biweekly, monthly, etc.).
STEP 3: PRINTING THE PAYCHECK
This is usually the simplest part of the process; the fraudster usually doesn’t need to take an active part in printing the check once the payroll information is in the system. Most accounting systems automatically create paychecks for employees based on the input pay data. The payroll system can’t distinguish a real employee from a ghost as long as the per- sonnel and time information looks the same, so it creates a check for the ghost employee just as it would for anyone else in the system.
STEP 4: DISTRIBUTING THE GHOST EMPLOYEE’S CHECK
After the check has been created, the final step in the process is getting the check from payroll into the hands of the fraudster. In many cases, this isn’t difficult. If the checks are distributed by the payroll office, then the employee who created the ghost employee can simply remove the check from those that are distributed to legitimate employees. Similarly, the checks may be distributed by the employee’s immediate supervisor, in which case the supervisor who created the ghost employee or who col- luded with the payroll department simply removes the check.
When checks are mailed or deposited directly to the employee’s ac- count, some additional work is necessary. If the check is mailed, the fraudster must be sure it is sent somewhere to which he or she has ac- cess. This may be as simple as using the fraudster’s home address, but it can also encompass the addresses of friends and relatives or post office boxes. The same is true for direct deposit. However, working around di- rect deposit is slightly more complicated. As the result of provisions in the PATRIOT Act, individuals are now required to provide evidence of their identity before opening an account. Therefore, a bank account pro- vides a clearer link to the fraudster than a post office box.
Paying Incorrect Wages and Hours
The second type of payroll fraud that’s likely to be encountered in li- braries is paying employees for more hours or at higher rates than they’re
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entitled to receive. In most cases, this fraud is perpetrated in the payroll accounting or human resources office. Typically a clerk who inputs hours and wages changes the pay rate for the employee or inputs more hours than the employee actually worked. A similar fraud can be carried out by someone in human resources who changes the employee’s base pay rate.
Less commonly, the employee commits the fraud, usually by reporting more time worked than was actually put in. (Very rarely, an employee will discover a way into the payroll system and change his or her own pay rate.) The approval of a supervisor should, in theory, prevent most em- ployees from submitting time sheets with more hours than they’re entitled to receive. This fraud thus can include colluding with the supervisor, forging the supervisor’s signature on time sheets, or altering time sheets once the supervisor approves them. Supervisors who approve time sheets without actually reviewing them also make this type of fraud possible.
Detecting and Preventing Payroll Frauds
The nice thing about payroll frauds, at least from the perspective of pre- venting them, is that by definition they’re tied to specific people, and not just any people. These people can be found in the workplace. This limits the number of places to investigate if you suspect a problem, and you can regularly ask your employees, unlike your vendors, to identify themselves as a condition of getting paid. This isn’t the only technique for dealing with payroll frauds, but it’s central to most of the methods we’ll discuss here.
Segregate Duties concerning Employee Hiring and Payroll
There are five basic payroll processes that should be separated among different people.
1. ENTERING AN EMPLOYEE INTO THE PAYROLL SYSTEM
To prevent ghost employees from entering the system, the ability to create a new employee account should be separated from the ability to prepare individual paychecks. Normally the ability to input a new em- ployee is limited to the human resources department. Similarly, human resources should be responsible for making any changes to an employee’s pay rate.
If the library is too small to have a separate human resources depart- ment, then the payroll system should at least be modified to prevent the employee who enters payroll data from adding a new employee or changing an existing employee’s pay rate. Most accounting software
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packages will allow you to segregate these functions with passwords, which should be controlled and limited to management.
2. AUTHORIZING PAY RATE CHANGES
As noted, rate change authorization should be limited to human re- sources personnel rather than individual supervisors or payroll employ- ees. Rate changes usually depend on promotions or time in position, so verifying this information is properly the job of human resources rather than payroll. Although promotions are usually based on the recommen- dations of an employee’s immediate supervisor, they should still be vetted through human resources. This not only deters fraud but also ensures that raises and promotions are properly documented and legal.
3. AUTHORIZING HOURS
It’s appropriate for supervisors to have the authority to verify the number of hours or days that an employee works, but not to input the hours or add the employee. When the same person has both duties, it becomes too easy to create a fictitious employee and verify his or her equally fictitious hours.
4. ENTERING HOURS WORKED
Inputting hours worked is really a clerical function. There’s no reason for accounting personnel who input regular payroll information to be able to change pay rates. Moreover, every time payroll data are input, they should have accompanying time sheets authorized by a supervisor.
5. DISTRIBUTING THE PAYCHECKS
In a perfect world, the person who distributes paychecks would not be involved in any other part of the payroll function. This is unlikely in most libraries, but at a minimum, neither the person who inputs the pay- roll data nor the one who authorizes hours should be charged with handing out the checks.
Verify Employee Identity
Periodically, the library should verify that the employees who receive paychecks really exist. The best way to confirm employees is to distribute paychecks to individual employees and require positive identification in order to receive the check. The library can follow the procedure even for employees who are paid via direct deposit. Such employees can be re- quired to produce identification to receive the transmittal notice that
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summarizes the gross salary, withholding, and amount deposited. The li- brary can further protect itself by delaying the transfer of funds until the employee’s identity is verified.
Employee verification is a powerful tool for preventing and detecting payroll fraud, but it’s effective only if the library management follows some additional steps:
1. The verification must be made by someone independent of the payroll process. It doesn’t do any good if the person who verifies employee identity is the same one who created the ghost em- ployee. It’s too easy to claim that the ghost employee appeared and produced identification if no one else saw it.
2. The verification should be unannounced. Given sufficient lead time, an enterprising fraudster can find someone to impersonate the ghost employee, complete with identification. Similarly, it’s common for ghost employees to be on vacation when paychecks are handed out.
3. The unclaimed checks must be properly secured after the identi- fication process is over. If the checks are left lying around, it’s easy to steal them or claim that the employee showed up later and re- ceived the check.
4. Library management must follow up on any unclaimed check. It isn’t enough to verify that an employee wasn’t there. If a check is unclaimed, it’s necessary to determine why. The employee might have been ill, on vacation, or nonexistent. It’s important to deter- mine why the employee was missing, and, if it is a ghost employee, who created it.
Compare Employee Addresses and Social Security Numbers
An easy test for ghost employees is to look for duplicate addresses. As we noted earlier, many fraudsters use their home addresses for the ghost em- ployees they create. The same is true for Social Security numbers. Fraud- sters often use their own numbers or numbers that differ by a single digit.
Obviously, an enterprising fraudster will be difficult to uncover using these tests, but many criminals aren’t that industrious, and in any case the tests are essentially without cost.
Set Limits on Paychecks
Most payroll programs can be configured to limit the amount of hours credited or dollars paid to an employee in a given pay period. By setting
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an upper limit, libraries can prevent the most egregious frauds. As with address verification, setting limits won’t catch a sophisticated fraudster, but it eliminates the worst fraud incidents at a very small cost.
Compare Payroll Records to Employee Files
Every legitimate employee should have a complete personnel file. Any em- ployee who appears in payroll but not in human resources should trigger an immediate investigation. Even if a file exists, however, it needs to be re- viewed for completeness. It’s extremely difficult to fabricate an entirely fictitious personal history. Any files that are incomplete should trigger fur- ther investigation. This control has the added advantage of ensuring that human resources has the information needed to comply with nonpayroll regulations such as equal opportunity and workers’ compensation.
Run Historical or Budget-Related Analyses of Payroll Expenses
Ghost employees create increased payroll expenses. An easy diagnostic test for payroll is to determine whether more is being spent this year than in previous years or than was budgeted for. An unfavorable variance doesn’t mean a ghost employee exists, but higher labor costs are worth investi- gating to determine whether the library is exceeding its budget and why.
In addition, supervisors should be required to periodically review their payroll budgets to ensure that everyone who is being paid actually works for the department. (Supervisors should regularly review all of the cost and budget information associated with their areas to ensure that the numbers are accurate.) A supervisor’s review is particularly impor- tant in organizations that are far-flung geographically or have large staffs, because it may not be possible to know everyone personally.
Have Supervisors Keep Copies of Signed Time Sheets
If a problem develops with altered time sheets, it may become necessary to investigate whether they were altered after the supervisor signed them.
A copy in the supervisor’s possession can help determine if an employee forged or subsequently altered a time sheet.
Have Supervisors Send Their Approved Time Sheets Directly to Payroll
Time sheets should not lie around after they’ve been approved. Doing so increases the likelihood of an unscrupulous person altering them.
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Periodically Check Payroll Data against Approved Time Sheets
Every paycheck should be generated as the result of an approved time sheet. Managers should periodically review a sample of payroll transac- tions against time sheets to ensure that every paycheck is both authorized and written for the approved number of hours.